By the Numbers

AT&T does an about face on WarnerMedia

Meredith Contente | May 21, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

In an interesting turn of events, AT&T (T) recently announced that it would be spinning out WarnerMedia, which would then merge with Discovery Communications (DISCA), despite having closed on the Time Warner Inc. transaction less than three years ago. Management intends to refocus their efforts and financial resources on the core telecommunications business, a departure from its strategy behind the Time Warner acquisition of marrying distribution with content. The deal proceeds will help T attack its large debt load, which increased with its $27 billion spend in the recent C-Band spectrum auction. Net debt should be reduced by $43 billion upon closing of the transaction, expected in mid-2022, bringing the company much closer to its 2.5x net leverage target. The deal will fast forward its debt reduction target by a full year, helping T spreads collapse much closer to those of peer Verizon Communications (VZ).

We highlight the curve relationship between the two credits in Exhibit 1.

Exhibit 1. T vs. VZ Spread Curves

Source: Bloomberg TRACE; Amherst Pierpont Securities

Unlocking Value for T Shareholders While Improving the Balance Sheet

The deal, which is structured as a Reverse Morris Trust, will spin out WarnerMedia, which will be combined with 100% of DISCA. T shareholders will receive 71% of the common equity of the new company while DISCA will own the remaining 29%. T is expected to receive a combination of cash and debt relief totaling $43 billion from WarnerMedia at the spin which will bring net debt/EBITDA to 2.6x at close. According to T’s 8-k filed at time of the announcement, the WarnerMedia Spinco with assume the debt of the existing WarnerMedia business as well as pay a cash dividend T. Additionally, in certain circumstances, the WarnerMedia Spinco will issue to T debt instruments as well. T will continue with its debt reduction efforts post spin and plans to achieve net leverage of 2.5x by year-end 2023, which is one full year ahead of original expectations.

Exhibit 2. Transaction Summary

Source: AT&T Company Presentation; Amherst Pierpont Securities

The New T

The spin allows for T to now focus on its Mobility and Fiber Broadband businesses. On the Mobility side, T will look to continue to make profitable market share gains while investing transformation savings back into growing its customer base and retention of existing customers. With the recent C-band spectrum, T will also focus on accelerating the roll out of next generation network services. On the Broadband side, T plans to double its total addressable market for fiber while increasing customer penetration. Additionally, they plan to aggressively market to businesses, in an effort to improve the adoption rate.

While the Time Warner acquisition was going to help address the maturity of the phone business, the recent C-band spectrum spend highlights the importance of remaining competitive. T released annualized pro forma growth expectations post spin with revenues expected to grow in the low single digit range (2022-2024 CAGR). Adjusted EBITDA is now being forecasted to grow in the mid-single digit range, fueled by strong ROI from both its Mobility and Fiber Broadband investments. Adjusted EPS is also expected to be up in the mid-single digit range based on the aforementioned EBITDA growth coupled with reduced interest costs associated with the smaller debt profile. T plans to continue to pay a dividend but will be cutting its payout ratio to the 40%-43% range (down from nearly 55% in 2020). The savings from the dividend reduction will be reinvested back into the 5G and Fiber businesses. Free cash flow is now expected to be above $20 billion on an annual basis. We note that while T generated free cash flow of just over $29 billion for fiscal 2020, the expectation for free cash flow to be above $20 billion post spin is roughly $4 billion higher than annual free cash flow generated pre-Time Warner. We do not expect T to consider share repurchases until it reaches its 2.5x net leverage target.

Agencies Affirm Ratings Upon Deal Announcement

Moody’s affirmed T’s Baa2 rating and stable outlook post the announcement and highlighted that they believe the company’s second priority, after business reinvestment, will be to return the balance sheet to historical strength levels. Moody’s noted that they believe that is the correct priority order for T going forward. The agency also viewed the cut to the “outsized” dividend positively, as the proceeds from the reduction can help to further execute on its priorities. The stable outlook reflects the recovery and improvement in T’s operating performance as the pandemic subsides.

S&P took a slightly different approach by affirming the BBB rating while moving the outlook to stable from negative. S&P noted that they view the transaction favorably for T’s overall business risk. While the wireless business will now represent 70% of total EBITDA, they view the cash flows from the Mobility business to be relatively predictable given that they are subscription based. Furthermore, the debt relief should bring leverage comfortably below the agency’s threshold trigger for a downgrade.

Additionally, Fitch also affirmed their BBB+ ratings and stable outlook particularly due to the fact that the spin enables the company to hit its leverage target by 2023. Fitch forecasts that T’s EBITDA margins should improve to the high-30% range by 2024 which further helps to improve leverage metrics. Fitch believes the focus on the company’s core business helps it better to compete with T-Mobile, which combined with Sprint in April 2020.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.